Global logistics markets are seeing an unprecedented race for space. But construction has failed to keep pace with demand and vacancy rates have reached historic lows, especially in the most in-demand markets. Those two factors combined have given landlords the whip hand in negotiations, with the ability to drive ever-harder bargains for desperate tenants.
The drivers of demand are well attested: the return of consumption following the pandemic; supply chain challenges that have created bottlenecks for goods, driving the need to hold more inventory closer to customers and prompting onshoring of manufacturing operations; and the inexorable rise of e-commerce, with distribution networks adapting to provide ever more goods to customers, who are demanding ever-quicker service.
“Occupiers are knocking on our door and saying, ‘Please, we need space,’” observes Laurie Lagarde, head of EMEA logistics at CBRE Investment Management. “There is so much demand that we cannot find it for them. None of the big e-commerce and logistics operators know how to answer the demand from their customers and clients.”
In the hottest markets, close to ports and major cities, big owners of industrial space are virtually sold out. Ben Bannatyne, president of Prologis Europe, says: “Across our markets, our portfolio is something like 98 percent occupied. In Germany, it is completely occupied – so are the UK, the Netherlands and Sweden. These are numbers we have never seen before.”
Developers have found it difficult to step up construction activity to ease the shortage, however. “It is more difficult to build now,” says Logan Smith, head of European logistics at investor-developer Hines. “Land prices are increasing. Costs are going up because building components are also more expensive. Permitting and planning cycles are becoming longer.”
Similar conditions apply in the US and in the developed markets of Asia-Pacific. “It is a landlord-favorable market the whole world over. The pandemic has amplified that, and vacancy is historically tight globally,” notes Jason Tolliver, Americas logistics and industrial investor lead at Cushman & Wakefield. “In the US, vacancy is below 5 percent overall, and in a lot of the major markets it is below 2 percent.”
Logistics occupiers face a “dizzying array of business challenges,” he adds. “Not only is the real estate market tight, most of [occupiers’] other costs are accelerating. They need to carry more stock in more locations to drive throughput, which is an increasingly expensive proposition. Shipping costs are through the roof, and supply chain disruptions and labor continue to be top of mind.”
Beset by such challenges, tenants simply cannot afford not to have the right facility, and that has led to a shift in their attitude to real estate costs, argues Jack Cox, head of EMEA industrial capital markets at CBRE.
“Access to market is such a differentiating factor that in the context of urban logistics, buildings in the right locations are competitive weapons. Some of the decisions we have seen in terms of rental bids for leases are not being set by the head of real estate, but by the chief executive and chief financial officer because of the potential EBITDA impact on their business.
“In some markets, most clearly in London, rent is not an expression of land values, plus rising construction costs, plus yield. It is an expression of affordability.”
The combination of these factors has propelled industrial rents to rocket worldwide, and led to “difficult conversations” with occupiers, particularly those accustomed to leveraging their scale to secure favorable deals, says Bannatyne. “We are telling them really far in advance where rents are going and trying to be as transparent as possible. This is not Prologis being greedy. Land prices have gone up, construction costs have gone up. You could not build a warehouse today for last year’s rent.”
One of the most notable changes in the landlord-tenant dynamic has been the reversal of positions over lease lengths. Once landlords coveted the security of longer terms, while tenants craved flexibility. But now, many landlords are reluctant to lock in terms for an extended period, thereby potentially missing out on rapid rental growth, while tenants would prefer the opposite.
What the experts say: Rapid rental growth is a feature of industrial markets worldwide
Nathan Kane, head of research, Realterm
“Between 2000 and 2015, there was virtually no long-term growth in rents in the US industrial space when adjusted for inflation. Since 2015, we have seen 30 percent to 40 percent total growth. That is an unheard-of number.”
Leslie Lanne, executive managing director, JLL
“In markets with sub-2 percent vacancy, such as the Inland Empire and
New Jersey, we have seen historic rent growth of up to 17 percent annually. But even in Midwestern and tertiary markets where vacancy is 4 percent to 6 percent, we have seen rent growth of 7 percent, which is nothing to sneeze at either.”
Jack Cox, head of EMEA industrial capital markets, CBRE
“Rental growth forecasts have lagged what we have actually seen in markets that have low availability of land. We are seeing US- and UK-style rental growth performance emerge in the land-constrained markets of northern and western Europe.”
Ben Bannatyne, president, Prologis Europe
“Around 18 months ago we started to see really strong rental growth in the US. We knew it was coming to Europe. Rental growth for comparable space over the past year was around 5.5 percent, which does not sound that dramatic, but we are seeing in-place rents from when tenants last signed a lease three years ago up 25 percent to 40 percent.”
Chris O’Brien, executive director, capital markets, industrial and logistics APAC, CBRE
“We have seen 5 percent to 7 percent rental growth in APAC, with 10 percent in some markets, but not 10 percent to 15 percent year-on-year growth yet. But what is happening in America and Europe is now coming to APAC. We are getting to very low vacancy, which means we will have exponential rental growth.”
An emphasis on capturing rental growth makes sense for investors who foresee further inflationary pressures during a period when “the major yield compressions are behind us,” argues Cox. “There has been a real shift in mentality from leasing for value – getting the longest lease to secure the lowest yield – towards leasing for income. Capital markets have an increased appetite for shorter leases that offer near-term mark-to-market opportunities to drive total return on the income growth side, rather than being reliant upon yield compression.”
Most landlords are now reluctant to offer leases with renewal clauses, which allow tenants to roll over their terms at the current rent. In some cases, occupiers that want long leases are unable to obtain them.
Meanwhile, other landlords are locking in higher periodic uplifts, observes New Jersey-based industrial specialist Leslie Lanne, executive managing director at JLL. “Owners that want to hedge their bets are looking at long-term deals with increased annual escalations: 2.5 percent to 3 percent used to be the norm in the US, and now we are seeing owners pushing for 3.5 percent to 5 percent annual increases in many markets.”
Fighting for space
With standing stock in short supply, it is not unusual for more than one tenant to compete for a single building. But bidding wars are not a common feature of the market, says Lagarde. “In this industry, it does not work like that. However, we are very mindful of the financial strength of the tenant. One day you will sell your building, and names like Amazon, GXO and DHL trigger premiums on the pricing. If one of them and a small tenant are competing for a building, both prepared to pay the rent, it is not hard to guess which a landlord would choose.”
Ease of doing business is often the deciding factor, adds Bannatyne. “You might have two of your good customers fighting for the same space; it comes down to someone signing first, timing, who is easiest to deal with.”
Occupiers must be ready to make swift decisions, counsels Tolliver. “There are very few options in the market, so tenants do not have the luxury of taking their time. If you are going out and surveying the market, you are maybe lucky if you have five buildings. By the time you set up the tours, you may be down to three, and if you dilly-dally while you tour them, you are probably out of all of those options. It is being prepared and proactive instead of reactive.”
End users with strong credit, and a year or two to select a greenfield site, can still strike favorable deals on build-to-suit space, argues Chris O’Brien, executive director, capital markets, industrial and logistics for APAC at CBRE.
“The appetite from capital and need to build scale is so strong right now, and yields are so sharp, that feasibility still stacks up with high rental incentives and low effective rents,” he says.
“The prelease market is entirely different to the stabilized market. A tenant with a 500,000-square-foot requirement that will sign up for 20 years will get an unbelievable rental deal.”
Tenants willing to stray outside their core business can insulate their business from rental cost escalation by acquiring land and self-developing for owner-occupation, notes Cox. “For example, [logistics provider] DHL has been utilizing its balance sheet to participate in the profit from development and offer its customers a lower rate of rent.”
While development activity will inevitably ramp up, the most desirable logistics markets close to ports and major cities are naturally supply-constrained because of the multiplicity of competing uses for a finite supply of land. They are likely to remain landlords’ markets for the foreseeable future.
Hines’s Smith cautions that it is important to put that into the perspective of long-term trends in the logistics sector, however.
“The occupiers will continue to have the lion’s share of the balance of power, and it should be that way. Together, Blackstone and Prologis and Segro have about a seventh of the market capitalization of Amazon, and there are 10 companies that size focused on logistics and industrial real estate right now,” he says.
“We are still incredibly small relative to the scale of the occupiers that are focused on this sector. We are humble service providers. A pawn on the chessboard.”